Understanding Bond

Futures and Valuation

David Lee

FinPricing
 Bond Futures

Summary
 Bond Future Introduction
 The Use of Bond Futures
 Valuation
 Practical Guide
 A Real World Example
 Bond Futures

Bond Future Introduction

 A bond future is a future contract in which the asset for
delivery is a government bond.
 Any government bonds that meet the maturity
specification of a future contract are eligible for delivery.
 All eligible delivery bonds construct the delivery basket
where each bond has its own conversion factor.
 Conversion factors are used to equalise the coupon and
accrued interest differences of all the deliverable bonds.
 The seller usually picks up the cheapest bond in the basket
to deliver, called the cheapest-to-deliver (CTD).
 The CTD bond is normally delivered on the last delivery day
of the month.
 Bond Futures

The Use of Bond Futures

 Bond futures are exchange-traded with maturities of 2, 5, 10,
30 years, where the typical underlings are treasury notes or
bonds.
 There are established global markets for bond futures.
 Bond futures provide a liquid alternative for managing
interest rate risk.
 Investors use bond futures to hedge an existing portfolio
against adverse interest rate movements or enhance the long-
term performance of the portfolio.
 Arbitrageurs profit from the price difference between the spot
bonds and the bond futures.
 Speculators use bond futures in the hope of making a profit
on short-term movements in prices.
 Bond Futures

Valuation
 The present value of a bond future contract is represented
as:
𝐹𝐵 (𝑡, 𝑇)
𝑃𝑉 𝑡 = 𝑛𝑁 − 𝐾 exp(−𝑡𝑇 𝑇)/100
𝐶𝐹
where
• t the valuation date
• K the delivery price
• n the number of contracts
• N the amount value for the bond future
• T the future maturity date
• CF the conversion factor for a bond to deliver in a bond
futures contract
 Bond Futures

Valuation (Cont)
• 𝐹𝐵 𝑡, 𝑇 = 𝑃 − 𝐶Σ exp 𝑟𝑇 𝑇 − 𝐴 the forward clean
price of the delivered bond (CTD) at t
• P the bond dirty price at t
• 𝑟𝑇 the continuously compounded interest rate between t
and T
• 𝐶Σ = 𝑡𝑖 ≤𝑇 𝐶𝑒𝑥𝑝(−𝑟𝑖 𝑡𝑖 ) the present value sum of all
coupons of the underlying bond between t and T
• A the accrual interest before T.
 Bond Futures

Practical Guide
 The key for pricing a bond future is to compute the forward clean
bond price.
 The forward clean bond price is equal to the forward price of the
underlying bond price at today t plus some coupon and accrual
interest adjustment.
 𝑃 exp 𝑟𝑇 𝑇 is the raw forward price from t to T.
 𝐶Σ exp 𝑟𝑇 𝑇 is the forward price of all the coupons between t and T.
Those coupons should be excluded from the forward bond price at
T.
 𝐴 is the accrual interest before.
 Bond clean price = bond dirty price – accrual interest
 Bond Futures

A Real World Example

Buy Sell Sell
Currency USD
Contract Size 50000
Conversion Factor 0.8272
First Delivery Date 6/1/2017
Last Delivery Date 6/30/2017
Future Ticker TYM17
Future Ticker Size 64
Future Ticker Value 15.625
Number of Contract 83
Quote Price 124.46875
Trade Date 2/23/2017
Future Maturity Date 6/21/2017
Underlying Bond Type UST
Underlying Bond Coupon 0.0275
Underlying Bond Maturity Date 2/15/2024
Thank You

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